Reverse mergers – A unique mechanism in M&A transactions

A reverse merger is a form of merger and acquisition (M&A) in which a private company or subsidiary of a group of parent and subsidiary companies (consisting of multiple companies) merges into a target company (usually a publicly listed company),  and the target company becomes a surviving corporation after the merger. This mechanism allows the buyer to gain control of the target company without issuing new shares to the public, while ensuring that the legal structure and operations of the target company are maintained after the merger.

 

 

In the context of increasingly complex M&A transactions, reverse mergers have become a popular strategic tool, especially when companies want to scale, enter new markets, or leverage the target company's brand and infrastructure.

1. What is a reverse merger?

A reverse merger is a transaction in which a "shell" public company – with little or no business – acquires an active private company. Shareholders of a private company exchange their shares to hold a majority of the shares and voting rights of the public company. At that time, the public company continued to exist after the merger, but the management team and business activities mainly belonged to the former private company[1].

The reverse merger process can be specifically described as follows:

• A merger sub of the acquirer merges into the target company.
• The target company becomes the surviving corporation, retaining its legal and organizational structure.
• The shares of the subsidiary are converted into shares of the other company, while the shares of the target company are converted into cash or other interests, resulting in the buyer gaining control of the other company.

Compared to a traditional merger, a reverse merger has a number of outstanding characteristics:

• Maintain legal structure: The target company continues to exist as a legal entity, retaining existing licenses, contracts, and brands.
• Time and cost effectiveness: Reverse mergers are typically faster and less expensive than issuing new shares or conducting an IPO.
• Centralized control: The buyer (through a subsidiary) becomes the sole shareholder or the dominant shareholder of the other company.

In the Ferrero-WK Kellogg Co[2]. transaction, the reverse merger mechanism was used for Ferrero to gain control of WK Kellogg Co., a company known for its grain brands, in order to expand its product portfolio and strengthen its presence in North America.

2. The role of reverse mergers in M&A transactions

Reverse mergers play many important roles in M&A transactions. It is also the main reason why many parties involved in M&A transactions implement reverse merger mechanisms to achieve desired business goals.

2.1. Leverage the legal structure and branding of the target company

Reverse mergers allow the buyer to leverage the intangible and tangible assets of the target company, such as brands, business licenses, or existing contracts, without the need for complex legal restructuring. In the case of Ferrero-WK Kellogg Co, WK Kellogg Co is a company with iconic grain brands, and maintaining the legal structure of this company helps Ferrero continue to operate those brands without rebuilding from scratch[3].

2.2. Simplify the control process

A reverse merger allows the buyer to gain control of the target company through the conversion of the subsidiary's shares into the shares of the other company. This eliminates the existing shareholders of the target company (by paying cash) and ensures that the buyer becomes the sole shareholder, as detailed by us in the Ferrero-WK Kellogg Co transaction.

2.3. Mitigation of legal and regulatory risks

By retaining the legal entity of the target company, reverse mergers minimize the risks associated with the transfer of licenses, contracts, or legal obligations. In this transaction, the closing conditions emphasize compliance with antitrust regulations and ensure that there is no legal injunction prohibiting the merger from the relevant regulator.

2.4. Financial efficiency

Reverse mergers are typically less expensive than outright acquisitions or IPOs, as they do not require the issuance of new shares or complex restructuring. In the Ferrero-WK Kellogg Co. transaction, the use of the Payment Fund to pay shareholders and owners of equity interests simplifies the distribution of finance.

3. Analysis of the reverse merger mechanism in the transaction of Ferrero and WK Kellogg Co

The merger between Ferrero International S.A. and WK Kellogg Co is a good example of a reverse merger mechanism. We will use this transaction to illustrate the form of the reverse merger mechanism in practice

3.1. Trading structure

Parties to the transaction

1. Ferrero International S.A. (Parent): A Luxembourg public limited liability company, acting as the buyer.
2. Merger Sub: A subsidiary established by Ferrero to carry out the merger.
3. W.K. Kellogg Co.: Target Company, a Delaware company with well-known grain brands.

Merger mechanism of the transaction

• According to the agreement between the parties, at the time of the effective date of the signed merger contract, the Merger Sub merges into WK Kellogg Co, with WK Kellogg Co becoming the other company.
• Merger Sub's shares were converted into common shares of the other company, making Ferrero the sole shareholder of WK Kellogg Co.
• WK Kellogg Co's common shares are converted into cash rights (per share price), and equity interests (RSUs, PSUs, DSUs) are cancelled and paid in cash.

 

The former headquarters of WK Kellogg Co and Kellanova in Battle Creek, Michigan. Source: Forbes

 

3.2. Stock swaps

In addition, the reverse merger mechanism in this transaction is carried out through a stock swap, as follows:

Shares of Merger Sub

Each outstanding Merger Sub share is converted into one common share of the remaining company. This ensured that Ferrero, through Merger Sub ownership, took full control of WK Kellogg Co post-merger.

Common Shares of WK Kellogg Co

• Each common share is converted into a cash entitlement, subject to adjustments as specified in the merger agreement.
• Shares owned by WK Kellogg Co or its subsidiaries (Treasury Stock) are canceled without receiving payment.
• Dissenting Shares are handled according to the right to valuation by law.

Equity benefits

Restricted stock units (RSUs), performance-based stock units (PSUs), and deferred stock units (DSUs) are canceled and converted into cash, based on the Per Share Price.

Payment Funds

Ferrero establishes a Payment Fund to distribute cash to shareholders and equity interest holders, ensuring that payments are made efficiently.

3.3. Conditions for closing transactions

The reverse merger mechanism requires meeting the conditions for closing the transaction, including:

• Shareholder approval: The merger agreement must be approved by a majority of WK Kellogg Co's shareholders at the shareholders' meeting.
• Administrative approvals: Complies with the Hart-Scott-Rodino Act (HSR Act) and other antitrust regulations, with notification reports filed within 20 business days.
• No legal injunction: There are no laws or legal orders prohibiting mergers issued by the competent authority.
• Tax opinion: Ferrero must obtain a tax opinion from a tax advisor to confirm the tax aspects of the transaction.
• Debt confirmation letter: WK Kellogg Co must provide a debt confirmation letter at least three business days prior to the Closing Date, confirming that the debts are paid or released.

3.4. Voting agreement

To ensure shareholder support during the reverse merger, Ferrero has signed Voting Agreements with major shareholders, including the W.K. Kellogg Foundation Trust (which owns 13,205,159 shares), the Gund Family Twelfth Investment Partnership, and the KeyBank National Association. These shareholders commit to: (1) Vote in favor of the merger contract. (2) Do not support alternative acquisition proposals. (3) Restrict the transfer of shares, except in permitted circumstances (such as transfer to relatives or family trusts).

The Voting Agreement helps ensure that the reverse merger mechanism is implemented smoothly, with support from key shareholders.

3.5. Commitment to employees

Ferrero is committed to maintaining WK Kellogg Co's Continuing Employees benefits for at least one year after the merger, including bonuses, vacation benefits, and retirement plans. This helps to minimize the risk of operational disruption, which is a key element in a reverse merger, where the target company continues to operate under the existing structure.

It can be seen that reverse mergers are applied by quite a few companies around the world today. One of the typical transactions involving a Vietnamese legal entity using this mechanism is Vingroup's use of a subsidiary in Singapore to reverse merge with the target company that has been listed on the US stock market in 2023. This was considered one of the largest mergers and acquisitions at that time[4].

The reverse merger mechanism is a powerful strategic tool in M&A transactions, allowing the buyer to effectively gain control of the target company, while maintaining the company's legal structure and branding. With the rise of global M&A transactions, reverse mergers will continue to be an important mechanism to support complex deals, bringing value to both the buyer and the target company's shareholders.